Value Hunting On The Street

This article “Value Hunting On The Street” by Jason Low was first published in The Business Times on 22 Sep 2008 and is reproduced in this blog in its entirety.

Tried and proven value investing is the way to go in these times and it may be time to start nibbling at some value stocks now, says JASON LOW

The recent few months have certainly been trying for investors. Some say that the markets have never been so bad since the Great Depression, with financial institutions faltering one after another and global stock markets plunging on every indication of trouble.

In his book Wall Street On Sale, author and value investor Timothy Vick talks about picking assets on the cheap. And it seems that bearish times like these are when value investors come out hunting for bargains.

Since the start of the sub-prime meltdown, investors’ confidence has been at an all-time low. In fact, investors’ risk aversion has never been so low in the past decade. The US dollar/Japanese yen cross rate, used often as a risk aversion barometer by the market, reached a historic low earlier this year.

For a value investor, such times represent a once-in-a-decade – some say once-in-a-lifetime – chance to pick up beaten stocks at very cheap valuations. It’s like your favourite departmental store offering more than 50 per cent discount!

In financial markets, however, there appears to be a tendency for investors to go against such a logic. They tend to buy only as prices rise. Yet as Mr Vick pointed out in his book, most investors would be better off behaving like the rational departmental store shopper and buy only when assets are on sale.

Picking A Value Stock

So how do we know when assets are on sale or at a discount? This is where the true blue value investors use some notion of value based on a company’s fundamentals and economic performance to determine the true value of the business.

Never ever look at the prices in determining how cheap or expensive the company is. Price and value are not always the same. Instead, you need to look at the company’s earnings as your first check of the company’s fundamentals.

A tried and proven method of successful investing is to buy stocks selling at a low multiple of their earnings. Earnings are what a company has left after it has paid its expenses.

A company selling at low earnings multiples is very often a better value pick than, say, another which is selling at a high earnings multiple. Of course, we have to compare the price-earnings multiple to its peer companies in the same industry and also the broader indices to determine whether this company is indeed a value buy.

Also, a company’s price to book value is an important measure of a company’s value, especially one in the financial industry. In fact, many see this as one of the best indicators of long-term returns of one’s investments. Those companies trading at a very low price-to-book ratios tend to outperform those with a high price-to-book ratios over the long run.

Indeed, stocks selling at low price-to-book value have outperformed their more glamorous and higher price-to-book value counterparts significantly. The former group has performed significantly better by anywhere from 6.3 per cent to 14.3 per cent annually over periods from 1967 to the present, both in and outside the US, based on various research papers done over the past century. This was pointed out by Christopher Browne of Tweedy, Browne Company – Wall Street’s oldest value investing firm – in his book, The Little Book of Value Investing.

And as many good old value investing books will tell you, having a “margin of safety” is imperative, especially in markets like this where it is possible to buy way below your perceived value of the stock if one is patient. This will not only minimise your chances of losses but also maximise your gains in the long run when the market recovers – as long as one is patient and disciplined enough to follow this strategy religiously.

Difficult To Time Market Bottom

Many investors aim to buy only at the market bottom. But many fail simply because it is often harder to predict the market bottom than to choose a value stock. Instead, given the current conditions right now, when many fundamentally strong stocks are priced at cheap valuations, it might be time to start nibbling on some of these value stocks, rather than attempt to catch the market at its bottom and risk missing out on this opportunity entirely. This is so long as you are comfortable with the value you get in return for the price you pay, and also after you have given yourself a decent margin of safety as protection from the potential downside.

It is also important to consider the qualitative aspects of the business. Buy only into a company that has astute leadership and a credible board of directors managing the company. It is also pertinent to understand its operating structure and learn about its future plans. A good value investor will personally talk to the management or representatives to seek first-hand information about the company before investing – and stay in constant contact with the company’s representatives for the most up-to-date information about the operations of the business.

Be disciplined and never be tempted to believe that you can time the market to profit from speculations. Successful investing is just old fashioned financial statements analysis, not some profound studying of charts to time the markets.

Value investing is no rocket science. But it requires more effort than brains to discover the best value stocks out there. Just be warned that value investing is not for those looking for a quick gain. Only those who are patient enough to see out the end of this entire sub-prime crisis and the start of the next bull run will make a decent gain on the value stocks that they have picked up today. Caveat emptor.

A good value investor will personally talk to representatives or the management to seek first-hand information about the company before investing.